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Private loan contract invalidated due to fraud, voiding also the contract of guarantee. Lawyers Niu Xingli and Wang Qingnan recover economic losses for the guarantor
Released on:2022-02-18


Should one of the parties to a loan contract is guilty of a criminal offence,the private loan contract is not necessarily void ab initio.In such a case,civil actions shall be considered holistically.For example,if the private loan contract which the suspect entered into may be voided on one of the grounds for contractual invalidity set forth in Article 52 of the Contract Law of the People’s Republic of China,the contract should then be deemed invalid(this case concerns a civil dispute which took place prior to the Civil Code’s entry into force.As such,it is governed by the provisions of the then effective laws and judicial interpretations)

Facts of the case:

On March 1st 2018,Li(borrower)and Yang(lender)entered into a loan contract.Li put up their house as collateral,with Zhao(the client in this case)providing ordinary guarantees.Subsequently,Yang discovered that the property which Li offered as collateral had already been sold in 2011,and the certificate of title provided when obtaining the loan was forged.Yang immediately filed a complaint with police.In 2019,Li was found guilty of fraud following a criminal trial and ordered to refund the losses.Because Li had no property which could be the subject of enforcement,the court decided to end the enforcement procedures thereagainst.In separate civil proceedings,Yang prayed that Li be ordered to repay the principal and interest,Zhao bear liability as guarantor and the defendants pay court costs.The court of first-instance found that the contract contravened the provisions of Articles 54 and 55 to the Contract Law,and were voidable contracts.Furthermore,the court found that the plaintiff forfeited their right to void the contract by bringing a suit,finding the contract therefore valid.The civil proceedings brought by Yang against Li was dismissed,Zhao was adjudged to bear guarantor liability and the plaintiff’s other demands were also dismissed.

Defense Plan:

Unsatisfied with the first-instance judgment,Zhao engaged King&Capital lawyers Niu Xingli and Wang Qingnan to file an appeal.Counsel was of the opinion that,although the validity of the loan contract in this case was not void ab initio by virtue of a party thereto being involved in criminal actions,it nevertheless was void,as it violated Article 52(3)and Article 52(5)of the Contract Law.As an ancillary contract,the contract of guarantee was also void,thereby freeing Zhao from having to bear guarantor liability.The court of first-instance erred in legal application by deeming the contract valid on the basis of Article 54 and Article 55 of the Contract Law,and should be corrected.

In the appeal and during the second-instance hearing,counsel contended that:1)in accordance with Article 52 of the Contract Law,contracts which seeks to cloak an illegal object with a fig-leaf of legality are void.In the present case,Li sought to defraud Yang of the loan monies with an object to illegally take possession thereof.He has been found guilty of fraud by a judgment which has entered into effect.Therefore,the loan contract should be deemed void.2)In accordance with Article 52(5)of the Contract Law,contracts which violate the compulsory provisions of laws and administrative regulations are void.The Second Judicial Interpretation on the Contract Law provides that“compulsory provisions”are those which have compulsory effect.Furthermore,Article 30 of the Summary of the Minutes of the Work Conference on Civil and Commercial Adjudication by National Courts clarifies that the question of whether a contract violates provisions which are of compulsory effects involves a balancing of legal interests and a surveying of the legal consequences precipitated by the illegal act.If the illegal act is capable of producing serious social harm,bordering on infringements of the criminal law and resulting in criminal sanctions,then the contract should be deemed void.3)In this case,Li has already been found guilty of fraud by a criminal judgment of the people’s court.The money involved in this case cannot be deemed both as‘criminal proceeds’and a‘loan’.Li fraudulently obtained the money in this case,meaning that there is no loan relationship.Zhao is therefore exempt from bearing guarantor liability.As the victim,Yang’s legitimate rights and interests should be remedied through the criminal proceedings of asset recovery,and the civil suit dismissed.

As the principal contract,the loan contract is void due to the reasons outlined above.Furthermore,Article 5 of the Law of Guarantee provides that“the contract of guarantee is ancillary to the principal contract.Where the principal contract is voided,the contract of guarantee is similarly void.”The client shall bear no guarantor liability.

A New Judgment Entered

Upon holding a hearing,the court of second-instance accepted our submission that the loan contract is void as it satisfies Article 52(3)of the Contract Law.Our prayer for appeal was answered in part,with the court recognizing that“Zhao’s grounds for appeal are granted in part.The court of first-instance was clear in its recognition of the facts but erred in its application of the law.Its findings are corrected accordingly.”In its judgment,the court noted that“following the invalidation of a contract of guarantee,should the lender,guarantor or borrower be at fault,they shall bear civil liability in proportion to their respective degrees of fault.Where the guarantor is at fault,they shall not bear more than one-third of the portion of liability which the borrower is unable to repay.Appellant Zhao provided a guarantee without authenticating the certificate of title provided by Li,and is therefore at fault.Zhao shall thus be liable for one-third of Li’s default amount.”

The second-instance judgment set aside the lower court’s judgment insofar as it ordered Zhao to bear guarantor liability.Counsel successfully mitigated economic losses for their client.

Significance of the case

If the action of either borrower or lender amount to a criminal offense,whether on the facts or by judgment which has already entered into force,and the other party brings a civil action,the private loan contract is not necessarily void ab initio.Its validity should be further explored and assessed against such provisions as Article 52 of the Contract Law.As a practical exploration of the aforementioned stance,this case is enormously instructive for the handling of similar cases,reducing guarantor’s civil liability and safeguarding the legitimate interests thereof,in cases where the invalidation of the principal contract causes the ancillary contract of guarantee to be voided.It also underscores the professionalism and capabilities of King&Capital lawyers in handling such complex and controversial cases.

At the same time,readers shall beware that,when providing guarantees for the loan of another,please perform due diligence in order to avoid providing guarantees without verifying the certificate of title of the property provided by the borrower.Such an oversight or other similar fault may cause the guarantor to bear and perform the liability to pay civil damages when the borrower is incapable of paying back the loan.